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27 Jun 2021
The institutionalization of Bitcoin
Bitcoin has come a long way since the early days of relative obscurity. The evolution is fueled by a flood of institutional money, both around the infrastructure but also directly into the asset.2021 has been marked by speedy institutional adoption, from corporates to hedge funds, to major investment banks revising their crypto initiatives. Most of the biggest names on Wall Street have now announced plans to offer their clients access to cryptocurrencies.This blog post is an extract from our latest report: “The Bitcoin Trading Ecosystem”. A few years ago, only technology-driven retail investors were interested in bitcoin. After the hype of 2017, many concluded that bitcoin was dead. However, large, traditional companies started building out the infrastructure around the leading cryptocurrency. In 2020, the institutional investors entered the public scene, embracing bitcoin as an ideal store of value and inflation hedge. This was partly a response to the monetary experiment from central banks and governments, initiated after the brutal market crash of March 2020.From billionaire hedge fund managers such as Paul Tudor Jones, to U.S. banks given the green light to hold customers’ digital assets, a remarkable shift in attitudes towards cryptocurrencies is evident. The recent increase in institutional demand highlights the growing legitimation of bitcoin as an asset class.Bitcoin’s unique properties separate it from nearly all other assets, with a fixed supply, a decreasing inflation rate, and a decentralized network maintained by thousands of computers worldwide without any central authority. There are several factors both near and long-term to support the increased awareness around bitcoin. Unconventional monetary policies increase risks of inflation and currency devaluation and the digitalization of finance encourage the adoption of digital currencies and related technologies.The brief bear market of 2020 marked the first time bitcoin faced a global economic crisis that threatened numerous investments across all financial markets. Bitcoin crashed brutally in mid-March but recovered quickly and never looked back.There is a fundamental difference between the current market and the events last time bitcoin topped out. In late 2017, the market was fueled by unregulated speculation in ICOs, totally inconsistent with organic growth. The focus was only on the massive gains investors got in the cryptocurrency market. We all remember the article stating that “Everyone is getting hilariously rich and you’re not”, which summarized the peak euphoria during 2017.In this current market cycle, and especially in 2020, the focus has been on institutional investors opening up for this new asset. It’s now being reported that public companies like Tesla acquiring bitcoin to hold as a reserve asset, and traditional financial institutions building out offerings to support bitcoin. The price of 1 bitcoin is currently hovering around $40,000 — 100% higher than the previous high in 2017 — confirming the strong demand.Institutional investment in bitcoin has long been considered paramount to a reach a multi-trillion-dollar market capitalization. With institutional infrastructure in place and growing, an optimal macro backdrop, and broader acceptance as an asset, the leading cryptocurrency is primed to receive allocations from institutional investors.It has become a lot easier from both a regulatory and practical perspective for institutional investors to hold and invest in bitcoin. Many institutions have been reluctant to embrace the asset, but this is now changing. Institutional investors have three main ways to invest in bitcoin: Exposure through spot markets like LMAX Digital, exposure through derivatives like CME’s bitcoin futures, and exposure through investment vehicles like Grayscale’s Bitcoin Trust. All have become exceptionally popular over the past year. As seen from the chart below, the volume growth on spot exchange LMAX Digital has been explosive over the past year. The exchange had $2.4 billion changing hands per day on average in May and reached record highs last month. Since LMAX Digital facilitates trades for institutions only and already is among the leading bitcoin spot exchanges, this depicts the current institutionalization of the bitcoin market.In terms of spot bitcoin to fiat trading, LMAX Digital has the second-largest volume in the market. The inflow of institutional money seems to have become a self-reinforcing mechanism, especially following the high-profile investments of Square, MicroStrategy, and Tesla.As seen from the chart below, the trading volume for CME’s fully-regulated bitcoin futures has grown significantly since the beginning of 2020. On average, more than $2.6 billion worth of bitcoin futures changed hands daily on CME in May this year. Moreover, from the beginning of 2020, the open interest increased from around $200 million to above $3 billion, before decreasing to around $1.5 billion again with the latest market correction. These contracts are only available for institutional investors and show the explosive demand for bitcoin exposure from this investor group. Although several crypto funds today effectively work like an ETF, the first to carry the ETF label was introduced in Canada in February this year. Several issuers have lined up to get approval for the first Bitcoin ETF in the U.S., but none have been approved yet.Part of bitcoin’s value lies in its ability to be self custodied. However, many institutions are unwilling to expose themselves to the risks associated with it. Instead, they seek custody solutions for digital assets as robust as those for traditional assets. Lately, we have seen the arrival of trusted custodians in the bitcoin market. Large financial institutions like BNY Mellon, Standard Chartered, and Northern Trust are getting ready to enter bitcoin custody, eliminating one of the biggest hurdles to invest for many traditional investors.Moreover, Fidelity has already built a bitcoin custody service for its institutional clients. These traditional firms are joining several crypto native custody providers, such as Coinbase, Gemini, and BitGo. The dominos are falling fast.With the domino effect at play, the trend of rising institutional demand is expected to continue. Some are beginning to dip their toes into the market. We have seen traditional financial players gain exposure to the market through their investment portfolios. Examples include Goldman Sachs investing in BitGo, Visa investing in Anchorage, Boston Consulting Group investing in Bakkt and BNY Mellon investing in Fireblocks.Bitcoin is becoming increasingly legitimized through the growing market and infrastructure, and continues to attract the attention of both retail and institutional investors as an emerging asset class.